How Can I Secure a Sustainable Retirement Income?
This article will explain what metrics you should consider when forecasting growth, whether before or during retirement and why. It will also provide some insight into how you can prepare for the worst-case scenario and how to run pessimistic, realistic and optimistic outcomes for your retirement. When forecasting for retirement, it is important to use forward-looking metrics as well as past performance to provide the most accurate analysis.
What predicted return rate should I use to forecast future returns?
Whether you are an active or passive investor, you will notice that when you analyse the past performance of a selected fund, the fund will compare the performance against a benchmark. 85% of active funds underperform the benchmark meaning it is important to work with an adviser that can illustrate they consistently outperform the benchmark. The most reputable and widely used benchmark is the “IA Sector Benchmark”. For example, the “IA mixed investment 0-35% shares” is a benchmark to compare cautious portfolios against.
How can an adviser illustrate whether my retirement goals are achievable or not?
It is important to work with an adviser that is up to date with the most recent technology and understands how to use this to your advantage. Cashflow modelling is a way to illustrate whether your income is sustainable throughout retirement and beyond retirement to future generations should that be a need for you. This useful tool can forecast whether your retirement income is achievable based on guaranteed and non-guaranteed income.
Given the personal circumstances above, we can run a cash flow forecast which incorporates state pension income, returns and the impact of inflation. We can tweak the model to incorporate which assets to draw down from first from a tax perspective and return potential. For example, cash is eroded by inflation and is liable to UK IHT if you are considered UK domiciled. In this example, cash would be the first asset to utilize followed by investments outside of pensions. Pensions would be utilised last as the assets are protected against IHT. This is why you see the pension as the last asset to remain.
As you can see, even if this client retires on the day of the start of the financial crisis in 2008, they would have significant assets at age 100. This client clearly has room to increase their retirement income and can consider leaving significant amounts of money to loved ones as well.
Is there a way to guarantee the above figures?
In life, the only guarantees are death and taxes, although there is an option to run a “Monte Carlo simulation” which is a computerized mathematical technique that allows you to account for risk in quantitative analysis and decision making. Monte Carlo simulation furnishes you with thousands of possible outcomes and the probabilities they will occur for any choice of action. Please see an example of what this looks like for the same client example for a cautious portfolio. The example shows 100% of simulations didn’t run out of money before the age of 100.
For example, cash is eroded by inflation and is liable to UK IHT if you are considered UK domiciled. In this example, cash would be the first asset to utilize followed by investments outside of a pensions. Pensions would be utilised last as the assets are protected against IHT. This is why you see the pension as the last asset to remain.
Furthermore, we are able to run different simulations based on return rate, inflation rate and even market events such as if you retired the day of the 2008 financial crisis.
Example – the past performance since 1990 of our selected asset allocation
As you can see, given the past performance of a portfolio that has 80% invested into equities and 20% invested into bonds, the fund grows significantly. This client clearly has room to increase their retirement income and can consider leaving significant amounts of money to loved ones. There appears to be almost no risk to the retirement income running out before death.
Example – Market Event – 2008 Financial Crisis
Please note, the above examples are for illustration purposes. Investment returns can go down as well as up.
This communication is for informational purposes only based on our understanding of current legislation and practices which are subject to change and are not intended to constitute, and should not be construed as, investment advice, investment recommendations or investment research. You should seek advice from a professional adviser before embarking on any financial planning activity. Whilst every effort has been made to ensure the information contained in this communication is correct, we are not responsible for any errors or omissions.
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